A SEP IRA (Simplified Employee Pension Individual Retirement Account) is a retirement savings plan designed for self-employed individuals, small business owners, and freelancers who want a tax-deferred way to invest for retirement with higher contribution limits and fewer administrative requirements than a traditional 401(k). It’s one of the most straightforward retirement accounts for those not employed in traditional W-2 roles, offering flexibility, ease of use, and significant tax benefits.
Although it’s called a pension, a SEP IRA is functionally similar to a traditional IRA, with the main difference being how contributions are made and how much can be saved. For people with inconsistent income or variable business revenue, the SEP IRA allows them to adjust contributions based on what the business can afford in any given year.
Contribution limits
In 2025, a SEP IRA allows contributions of up to 25% of net compensation (after deducting self-employment tax) or $69,000, whichever is lower. This limit is significantly higher than the $7,000 annual cap on traditional or Roth IRAs.
For sole proprietors and single-member LLCs, calculating the maximum contribution can be complicated, since it’s based on net earnings from self-employment, not gross income. The final amount allowed is closer to 20% of net income once the IRS formula is applied, due to how the deduction interacts with itself.
Only the employer can contribute to a SEP IRA — employees cannot make deferrals. For a sole proprietor, the business owner and the employer are the same, so this distinction is only important in multi-employee settings.
Employee rules
If a business has employees, a SEP IRA requires that the same contribution rate be applied to all eligible employees, not just the owner. To be eligible, employees must be:
- At least 21 years old
- Have worked for the employer in at least three of the last five years
- Have earned at least $750 in compensation during the year (2025 threshold)
This rule limits flexibility for employers who want to contribute only for themselves. If the business has employees and wants to avoid the uniform contribution requirement, a different plan — such as a Solo 401(k) or SIMPLE IRA — may be more suitable.
Tax treatment
Contributions to a SEP IRA are tax-deductible to the business and reduce taxable income for the self-employed individual. The money inside the account grows tax-deferred, meaning no tax is owed on dividends, interest, or capital gains until the funds are withdrawn.
Withdrawals taken in retirement are taxed as ordinary income, just like distributions from a traditional IRA or 401(k). If you withdraw funds before age 59½, the standard 10% early withdrawal penalty applies unless an exception is met.
There are no Roth features with a SEP IRA. All contributions are pre-tax, and withdrawals are fully taxable.
Investment flexibility
A SEP IRA can be opened at most banks, brokers, or financial institutions. Once funded, it behaves like a traditional IRA. Account holders can invest in stocks, bonds, mutual funds, ETFs, or other standard investment products.
There are no built-in fund lineups or preset portfolios. The individual or advisor managing the account controls the investment selection. This flexibility makes it useful for those who want to build diversified, low-cost portfolios over time.
Administration and setup
Setting up a SEP IRA is straightforward. There’s minimal paperwork and no annual IRS reporting. Employers must complete IRS Form 5305-SEP or use a provider’s version of the form. Once established, contributions are made directly into each employee’s individual SEP IRA account.
Unlike a 401(k), there are no requirements for annual nondiscrimination testing, no complex filings, and no need for third-party administrators. This makes it especially attractive for sole proprietors and small business owners who want a simple plan without added costs.
Required Minimum Distributions (RMDs)
As with traditional IRAs, SEP IRA holders must begin Required Minimum Distributions by age 73. There is no way to delay these withdrawals beyond that age, and there are penalties for failing to withdraw the required amount.
SEP IRAs also do not allow for Roth conversions within the account itself, but funds can be transferred to a Roth IRA, triggering tax on the converted amount. Some business owners use this as a strategic move in low-income years to reduce the tax burden on future distributions.
Practical uses and limitations
SEP IRAs are best suited for self-employed individuals with no employees, or for small businesses where the owner is comfortable contributing for everyone at the same percentage. They work well for those with fluctuating income, since there’s no requirement to contribute every year, and contribution amounts can vary from zero up to the maximum.
The biggest limitation is that employees cannot contribute on their own. That means SEP IRAs don’t function well as part of a salary deferral plan or employer match system like a 401(k). There’s also no Roth option, no loan provision, and less flexibility in shaping how and when employees can participate.
Seen from Pension Gruber
Guests from the U.S. who are self-employed — consultants, freelancers, small-scale professionals — often arrive with SEP IRAs forming the core of their retirement savings. The ones who contributed regularly during good income years often arrive with peace of mind. Those who ignored retirement planning during peak earning years and then scrambled to fund a SEP at tax time usually say the same thing: “I should’ve started earlier.”
The best outcomes tend to come from those who treated the SEP like a structured pension, even though the rules allowed flexibility. It’s an account that rewards discipline, not guesswork.
